Thinking globally: the US$ isn't the only currency!

The recent depreciation of China's exchange rate with the US$, to which it is pegged, garnered headlines. Until now those watching China believed that the RMB could only appreciate, leading to heightened foreign demand for Chinese assets by foreign speculators. Allowing a modest depreciation and increasing the intradaily trading band from 1% to 2% should discourage those expecting to make a quick buck by buying RMB today and selling tomorrow.

But how has the value of the RMB changed from a Chinese rather than a US perspective? China trades with the rest of the world and not just the US – Europe and Japan are major export markets and major sources of imports of luxury cars, machinery, semiconductors and other products – so the value of the RMB versus the Euro and the Japanese Yen also matters. Hence the concept of a trade-weighted exchange rate, conveniently provided in MS Excel format by the Bank for International Settlements in Basle, Switzerland. My graph presents their "effective exchange rate" calculation, to which I have added the bilateral RMB/US$, RMB/Euro and RMB/Yen rates, all indexed at 100 = average CY2010 value. Oh, and a higher value means a stronger RMB, and appreciation of its value, making it harder for firms in China to export and more attractive for them to import.

Because these other currencies move against the US$, there are periods when the RMB has appreciated or depreciated from the perspective of Chinese exporters and importers, even though the exchange rate was constant against the US$.

Toyota's Profits, Nissan's Lack

One year ago – 2012Q4 that is – Toyota lost money in North America, and made only modest amounts of money in Japan. Today is much different, in contrast to Nissan. Bloomberg nails the source: the yen boom.

Yes, the Japanese economy and the US economy are both doing better, and so therefore should Toyota. But others were profitable in the US in late 2012, and Toyota has not gained market share. My scan of Toyota's financial statements (with glances at those of Ford and GM) suggest the entire gain is due to a more favorable exchange rate. (I have yet to look at the reports of stock analysts to see their take.)

From Toyota's perspective this should be a cautionary tale. They now are rolling in profits, and have the opportunity to continue a restructuring pushed by Akio Toyoda, the firm's near-eponymous chairman. But it does suggest two big problems.

The first is that Toyota is not making substantial money on its North American operations – otherwise it would not have lost money last year. Yes, they have a good market share, but they face competition in key segments and are weak in light trucks (and then there's the failure of their full-sized pickup to gain sales commensurate with investment). Their lack of profits suggests these are major, not minor issues.

Do Toyota's vaunted cost controls no long provide them a competitive advantage?

The second is that Lexus remains their cash cow – which is primarily a US story – but the vehicles themselves come from Japan. When the yen was strong, Lexus lost money. With the weaker yen, that shifted dramatically (though not immediately since Toyota hedges their dollar receipts).

So Toyota needs to improve the bottom line on their US operations. That's surprising, suggesting that their vaunted cost controls are no long providing them a competitive advantage. Second, they need to move away from the yen cost basis on their most profitable products. Otherwise when the yen next strengthens profitability will again collapse. Given that the "cycle time" in the auto industry for realigning what is made where is measured in 4-6 year increments, they had better get moving.

Mike Smitka

Oh, and I did put Nissan in the title, but haven't looked at their financials. But as a quick cut, reverse the above logic: they're not booming because they've successfully aligned their cost base with their revenue base. Instead Nissan's profits will reflect markets strengths, not forex swings.